Stages in the Industry Life Cycle Ι Assumptions of Technical Analysis
Explanation of the stages in the Industry Life Cycle
Generally, industries evolve through three stages–the pioneering stage, the expansion stage, and the stabilisation stage. This concept of an industry life cycle applies to industries or product lines within an industry.
- Pioneering stage: During this stage, there is a rapid growth in demand for the company. Many companies fail at this stage as a result of strong competitive pressures while others achieve rapid growth in sales and earnings. The investors of such companies have a good chance of earning more than the expected returns. At the same time, the risk of the firm failing is also high.
- Expansion stage: In this stage, the pioneer firms that have survived continue to grow and prosper at a moderate growth rate. In this phase, firms focus on improving their products and at times lower prices. As firms have stabilised in financial performance companies they attract investment capital. This is because investors prefer to invest in these firms with a proven track record and a low risk of failure. Also, the dividends pay-outs are good that make it more attractive for the investor to buy the stock of these firms to investors.
- Stabilisation stage (maturity stage): This is a stage of moderate growth for firms. Sales increase, but at a slower rate. Products are standardised and less innovative while competition is stiff, and costs are stable. Such firms continue to operate without significant growth and are usually headed for stagnation.
The assumptions of Technical Analysis
Technical analysis is based on three assumptions:
- Price moves in trends: Technical analysts believe that security prices tend to move in trends that persist for long periods. This means that by establishing a trend, the future price movement is more likely to be in the same direction. Any shifts in supply and demand cause reversals in trends. These shifts can be detected in charts/graphs.
- History tends to repeat itself: Price movements/chart patterns mostly repeat the same patterns. Market psychology is considered to be the reason behind the repetitive nature of price movements. Market participants react in a consistent manner to similar market stimuli over a period of time.
Explanation of the tools used in Technical Analysis
There are many different types of technical traders; some rely on chart patterns, others use technical indicators and oscillators, and most use a combination of the two.
- Charting: Technical analysts are sometimes called chartists, because they study records or charts of past stock prices and trading volume, hoping to find patterns they can exploit.
- Technical indicators: Technical analysts also use technical indicators besides charts to assess prospects for market declines/advances. A technical indicator is a series of data points that are derived by applying a formula to the price data of a security. Price data includes any combination of the open, high, low or close prices over a period of time.
Technical indicators can be classified in many ways. They can be classified into three types:
- Sentiment indicators are intended to measure the expectations of various groups of investors, for example, mutual fund investors and corporate insiders.
- The flow of funds indicators is intended to measure the potential for various investor groups to buy or sell stocks, in order to predict the price pressure from those actions.
- Market structure indicators monitor price trends and cycles.